Dilutes DRIP existing stocks
Why should a company issue a stock dividend and how will that expense affect me?
Am I right to understand that a stock dividend involves issuing new shares instead of buying existing ones?
Yes. Instead of paying shareholders a cash dividend, the company grants existing shareholders new shares at a predetermined price. This enables shareholders who join the program to receive new shares without incurring the transaction costs that would normally arise if they were to buy those shares in the market.
Does this mean that if I don't participate in this program, my existing stocks will be diluted every time a scrip dividend is paid?
Yes, as the number of shares has increased, the relative percentage of shares in the company you hold will decrease when you opt out of the program. The price of existing shares will be adjusted so that the value of the company remains essentially unchanged (similar to a stock split), but the number of shares outstanding has increased so the relative weight of your shares will decrease when you opt out of the program.
What is the company's benefit in issuing scrip dividends?
Companies can do this to conserve their cash reserves. Also, by issuing a stock dividend, companies could avoid the Advanced Corporation Tax (ACT) that they would normally pay upfront on their distributions. Since the ACT was abolished in 1999, to my knowledge, maintaining cash reserves has been the primary reason for issuing stock dividends. Whether or not stock dividends are actually a beneficial strategy for a company is debatable (this looks like a decent study, though I've just skimmed it).
However, the problem may be beneficial to you as you may get a tax break. You can sell the stock dividend in the market. The capital gain from this sale may be subject to the annual tax free allowance for capital gains. In this case, you will not pay any capital gains tax on this amount. However, there is no minimum taxable amount on a cash dividend, so you owe dividend tax on the entire dividend (and therefore potentially pay more tax on a cash dividend).
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